The “Pay Yourself First” Budget (Part 2- Calculate your savings needed for your goal)

In the first part of our series, we carefully thought about our financial goals. Our next step is to calculate how much we need to save up to make our goal and add this as a line item on our budget. This may seem backwards for some, so let me explain.

Traditionally, you could create a budget based on what you spend and then use whatever is leftover to put toward your goals. In our budgeting style, you would set your goal, assign a dollar value and carve it out of your budget. Then you figure out how to make it happen.

Below we will use a hypothetical example of paying off school debt. Mrs. Doughmaker and I were intentional in picking this as it was a previous goal of ours and it can sometimes be tricky to calculate.

Mrs. Doughmaker and I graduated college in 2010 with roughly $44,000 in school loans combined. At that time, the average school loan debt per person was just over $25,000. This means we were below the average but it was still a mountain of debt to climb out of as two recent graduates. Our loans spanned 20 years of payments. Over the course of 6 years we made adjustments to our budgets and eventually paid off our school loans in full by 2016, thus opening up cashflow for future goals. The relief of not having a payment with interest levels higher than (3.5%) has consistently been one of our highest priorities.

Before going through our example, I want to show a sample calculation of what our student loans looked like when we first started paying them. This is an estimate (so not exact) but take a look at that highlighted section. For a $44,000 loan, we were paying $32,000 of interest!

For the following example, I will be using Bankrate.com’s Student Loan Calculator. It isn’t overly complex and gives you exactly what you need to calculate your goal. Let’s suggest that our goal is to pay off $20,000 in school loan debt over the next 4 years.

First, let’s navigate to the calculator and input our starting data, remembering we need to calculate where we are currently on our loans. In our example, we suggest that someone has loans totaling $20,000 at 5.8% interest with 15 years left to pay on those loans.

People may see this calculation and say “$167 per month is really not that bad” but I recommend looking at that number in the Total Interest Paid section. On this $20,000 loan one would end up paying an additional 50% in interest over the life of the loan. Almost $10,000.

The great part about this tool is we can see what would happen if we add extra monthly payments. Let’s see what happens to this example if we add another $100 in principal payments per month.

In this example, adding an extra $100 to the monthly budget towards student loans would save us $5,000 in interest.

If we click on the “Show Amortization Schedule”, we can also see another big benefit as well. We will also pay off our loan almost 8 years faster. Reading Amortization Schedules can seem a bit confusing at first, but it really lays out the cost of your monthly payment. Here is what ours looks like after we put an extra $100 monthly towards our loans.

Each month will show how much of our total payment will go to principal (lowering the balance of our loan) and how much of the payment goes toward interest as well as our monthly new balance.

Going back to our original goal, we want to pay off this $20,000 in 4 years. We just knocked off 8 years, but we need to make the calculation fit our goal parameters. So let’s find how much we would need to add to this loan payment to pay off the school loans by June 2024.

When I input an extra $300 per month to my loan, it shows we will save about $7,500 in interest over our original loan, and pay it off 11 years faster, finishing my final payment in June 2024.

So now that we have that data, we have to determine if this is a viable goal? Do we have an extra $300 we can apply to this loan monthly now? If not, can we utilize money from elsewhere? Next week I will show an easy way to set up a budget and determine if we can save toward this goal.